May

22

We are well into the Triple Crown season with just one race left to go. It's been fun for me so far as based purely on the name I liked I'll Have Another early on in both Derby Futures as well as Santa Anita. Now we have a decent shot at a real Triple Crown winner as the horse is one of the better closers we have seen in a few years and the length of the Belmont Stakes should favor the him. We have been disappointed several times since Affirmed in 1978 so we shall see what happens in two Saturdays.

I have always been a huge fan of horse racing, racetracks and all the associated depravity. Some of my fondest memories of the past decade are the trips we used to take to Keeneland in Lexington Kentucky every year for the Bluegrass Stakes. Lexington is a town founded by Irish gamblers and is made to order for me. A diverse group of traders, investors, professors and other assorted ner' do wells used to assemble for a long weekend of horse racing and bourbon drinking with the expected adventurous and occasionally disastrous results. I guess we all outgrew the trip or just got to busy but they will be telling some of those stories at my funeral in fifty years or so!

I don't hit the races or even the poker table the way I did in the past. A combination of marriage, kids, getting older, and the end result of the earlier explained IRR have kept me from wagering and whiskey in the quantities of days past. I still follow the ponies however and am always cognizant of the lessons learned at many racetracks and card tables over the years. A day at the track contains lessons in statistics, psychology, marketing, and a host of other scientific disciplines. Many of these I have found to be directly applicable to the markets and to life its own self.

The track contains many of the elements of the financial markets. You have the touters and system developers who look for the answer and failing to find it sell their services to others. It was Tom Ainslie who pointed out how these systems develop in his book on handicapping. *" A longshot wins a race. A disappointed bettor consults his Form and discovers that the longshot had been timed at 36 seconds in a breezing three-furlong workout a couple of days ago. No other horse in the race had worked so rapidly so recently. Powie! A new system is born!"* How many of these have you seen in the stock market. Someone curves fit data to show that the winning stocks of the past had a particular characteristic or price pattern and a brand new newsletter and web site is offered to investors as the answer to all their problems and a sure fire path to short term wealth. In truth none of it works any better on Wall Street than it does at the track but selling easy answers to greedy people has always been a source of profits for stock market and horse racing system developers.

Then there are the people you meet at the track. You have the bleary eyed beer soaked despondent souls who pick up discarded racing forms to search for a long shot winner to just get them back to even so they can start over again. They won once and hit some exacta or trifecta bets, usually by luck and have been chasing that short term success for a lifetime of almost and faded in the stretch. There are those who offer an informed opinion on each and every race with all the certainty of the Delhi Oracle. They bet each and every race and brag of their fantastic winnings before hopping in their classic car (a 1988 Buick Riviera with balding tires and cracked windshield) to head off to their luxury furnished studio apartment with a spectacular view of the railroad tracks and oil refinery. The stock market is full of these folks as well. The oracle of the last market cycle and the expert who never loses are everywhere on Wall Street and I am never sure if their hearts desire is to get to the winners circle or just drag as many others into their pool of disgrace and desperation as possible. Whichever the case, they are to be avoided in life, at the stock exchange and along the rail.

At every track I have been into in my life you can always find a few gentleman, usually older who sit through the race scribbling notes in their racing form each and every race. With the exception of perhaps a close friend or two they do not talk to anyone else or engage in the tip sharing and" who da ya like?" camaraderie of their fellow rail birds. They watch, take notes and perhaps sip a cold beer, or more likely a coffee. They wander off to the paddock before each and every race and the vast majority of the time they return to their seat to scribble some notes without bothering to place a bet. On rare occasions they get up, go the window and make a bet. These are the ones who have figured out the game. They only bet when they see an advantage and are more likely to fly over the grandstand than tell you how they derived their advantage. This is similar to investors who don't see the need to trade every day and only pull out their wallets when they have an edge and prices are favorable enough to offer a high probability of long term investment success.

One such astute gambler was among the best of them all. Pittsburgh Phil had a distinguished and successful career as a horse bettor. He once said *"Playing the races appears to be the one business in which men believe they can succeed without special study, special talent, or special exertion."* This is the case in the markets as well. So many people sit down and read a book or look at a chart and think that they, of all the speculators, traders and investors who came before them, have figured out the answer to market success. They do not study, research, or test and care little for other opinions. The worst thing that can happen to these people is initial short term success that makes them even more confident in their flawed opinions. Eventually the all go spectacularly bust. If this was easy everybody would be rich.

Phil, whose real name was George Smith also once said *"Know when to put a good bet down and when not to." *This is not only the best advice for horse gamblers but stock investors. Just because the window is open does not mean you have to get in the action. Patience pays at the racetrack and in the stock market. Just because they open the casino down at Wall and Broad does not mean you have to trade. Once a year or so you will get a steep decline in stock prices that carry 10 to 15% lower. Every few years you will get a gullywhumper of a selloff and prices will fall 20% or more from the highs. That's when you want to invest your cash. Keep in mind the excellent advice not only of Pittsburgh Phil but Henry Clews in his investing classic, 28 Years on Wall Street as well. *"But few gain sufficient experience in Wall Street to command success until they reach that period of life in which they have one foot in the grave. When this time comes these old veterans of the Street usually spend long intervals of repose at their comfortable homes, and in times of panic, which recur sometimes oftener than once a year, these old fellow will be seen in Wall Street, hobbling down on their canes to their brokers' offices. Then they always buy good stocks to the extent of their bank balances, which have been permitted to accumulate for just such an emergency."*

When I was a more frequent visitor to the track I used to look for horses that were stepping down in class in a race. I looked for a horse that had run middle of the pack races in higher dollar stakes race and are now stepping down a bit. If I could find a horse in a $50,000 stakes race that had run a few $100,000 races and had placed third or fourth I was interested. Racing against lesser competition the horse had a strong chance of running well and the past performance figures against better horses usually gave longer odds than should have been the case. The biggest ticket I ever cashed came from finding two of them in one race and hitting a badly underpriced exacta. It also provided a pretty steady diet of simple win tickets over the years. To me this is a lot like buying fallen angel stocks. Former blue chips that have had a reversal of fortune and fall into single digits have provided a fertile shopping ground for winning stocks over my career. It also applies to people. I am more comfortable being associated with someone who has fallen or failed and gotten back up to run again that I am with someone who has yet to taste defeat and disappointment. These temporarily blessed souls usually think it is their brilliance rather than circumstance that has so blessed them. When the fecal matter hits the the fan as it always does they are apt to become unreliable partners or friends in my experience.

If I was betting on a rainy day I always wanted to look for the mudder in the race. Some horses like Storm Cat just love the mud and run very well thought the slop. I have seen horses that need a taxi to reach the finish line on a dry day win by 10 lengths when the rain is falling and the mud is thick. This plays out in the stock market as well. Even in a crappy market and economy like 2008 there were some companies that will benefit from current conditions. In 2008 as the world and portfolio values sank like a well-ventilated submarine companies that catered to low end bad credit consumers did very well. AaronRents, Dollar Tree, Wal Mart, Family Dollar and others that catered to the broken consumer saw their stock prices do very well. Last year it was energy stocks and companies that sold to a resurgent upscale consumer that ran to victory in a flat market. In every economy and market condition there is a group of companies that will benefit and buck the trend.

There a lot of comparisons found at the track that apply to markets and to life. That sleek looking thoroughbred that goes off at short odds may win a good percentage of the time but if you bet him every race he will take your wallet for a ride. He will do well for his owners but gamblers will go broke betting short odds. The same can be said of buying high growth issues at very high multiples and trophy wives. The feisty little colt at long odds that has run well in the past but is under bet can make you a fortune. So can stocks that are experiencing temporary difficulties or just ignored by the investing public. The stunning high maintenance slut queen at the bar may attract all the attention but it is the good looking smart quite woman in the corner that will make you happy man for decades of life. Flash and short odds does not reward in any endeavor as does substance with a high payout.

I love the race track. Not only is it enjoyable and some of the best people watching you will ever experience but you can gain an MBA in Investing and Life $2 at a time.

Sam Marx writes:

But how does one overcome the 17% edge that the track has?

The stock market vig was high in the days of fixed commissions but now you can have the edge in certain markets such as options especially options that are traded with a penny spread.

Tim Melvin adds:

The article is not intended to suggest one make their living at the track. Merely that there are lessons to be learned that may be applicable to markets and other areas of life…

Stefan Jovanovich comments:

Tim's wonderful piece is better advice than some of us deserve. At the risk of being one of the beer-soaked wretches who used to hang on the rail at Hollywood Park, I have a "fallen angel" tip for the $2 bettors that even meets Tim's ''fallen angel" criteria: AMAT. And, if you want to make it a 2-horse parlay, add KLAC. The foundry business is like coking coal in the 19th century– ugly, unattractive and essential, as Mr. Carnegie and Mr. Frick well knew.

Sam Marx writes:

From my experience of going to the track, always with a friend who talked me into it, I found interesting characters and observations there.

But I never bet there, even at the $2 window. Same with slot machines at Vegas or A.C.

Logically I know that a $2 bet would've given me something to root for, increasing my enjoyment at the track for a small amount, but my aversion to betting when the edge is against me is almost of a religious intensity.

To learn about markets and trading psychology when young, I'd recommend the stamp or coin market. If you know your markets there and try to avoid having the urges of a collector but as a trader and buy at close to wholesale prices, you'll do well.
Tim's piece was a very enjoyable read but I don't think horse players are the best source for learning about markets.